A Foreign Non-Grantor and Grantor Trust TaxationOverview

Foreign Trusts (Grantor vs Non-Grantor)

U.S. Taxation of Foreign Trusts

The US tax system can be very confusing, especially when foreign income is involved. That is because, unlike most other tax systems across the globe, the United States follows a Citizenship-Based Taxation model. This means, that if a person is considered a U.S. Person such as a U.S. Citizen, Lawful Permanent Resident, or foreign national who meets the Substantial Presence Test, they are required to report their worldwide to the IRS. This is true, even if the U.S. person resides outside of the United States and/or if the income is sourced from foreign countries. Thus, if a U.S. person has foreign trust income, that income would presumably be taxable in the United States because it is ‘income’ (even if sourced from overseas) and the recipient is a US person. In general, foreign trusts can get very complicated due to the fact that the IRS has a big distaste for trusts located outside of the United States. Let’s take a look at the basics of foreign trust income and US taxation.

Worldwide Income

As mentioned above, from a baseline perspective the United States taxes worldwide income for taxpayers who are considered to be U.S. persons and not just U.S. citizens. Therefore, if a US person is considered the owner of a foreign grantor trust or the beneficiary of a non-grantor foreign trust – they can become subject to income tax on the foreign trust income/distributions.

Foreign Trust without US Assets

When the foreign trust has US assets in it, it can become even more complicated from a reporting perspective due to the resident vs non-resident tax and reporting rules. This is because a foreign trust with U.S. assets will generate both domestic and foreign income within the trust — and the tax treatment of the different types of income will be different as well, especially in situations in which PFIC or CFC income is involved.

Grantor Trust (US Person Owner)

When a US person is the grantor of a foreign trust, and the trust is determined to be a grantor trust, then the grantor is the person who is taxed on the income. It is important to note, even if the distributions are made to the beneficiaries, the grantor is still taxable on the income – this is done by the IRS to avoid income assignment to a lower-taxed person (who then may gift money back to the Grantor). Even if the income is not distributed, the grantor can be taxed on their respective share of ownership of the foreign trust.

Non-Grantor Trust (US Person Beneficiary)

With a non-grantor trust, it is the beneficiary that receives the distribution who is taxed. For example, if it is a foreign non-grantor trust that makes a distribution to a US person beneficiary, then the US beneficiary must report the income on their U.S. tax return. And, since most foreign trusts do not issue K-1s to the U.S. beneficiaries, the taxpayer will (hopefully) receive a Foreign Non-Grantor Trust Beneficiary Statement in order to delineate what types/categories of income were generated and distributed to the beneficiary.

Throwback Rule

When it comes to foreign trusts, the income tax rules are extremely nuanced and complex. Foreign trust income may be considered either DNI or UNI — and the tax rules are different than those for domestic trust income. Likewise, based on the throwback rule, income that is contained within the trust and not distributed in prior years may lose beneficial tax treatment and instead be taxed at the ordinary income tax rates, in addition to interest.

Current Year vs Prior Year Non-Compliance

Once a taxpayer misses the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.